HIVE Blockchain Technologies Ltd

XTSX:HIVE

Earnings Call Transcript 2020-Q3

[Darcy Daubaras, Chief Financial Officer]

Good morning. I'd like to welcome everyone to today's webcast for HIVE's Q3 fiscal 2020 financial results for the quarter ending December 31, 2019. My name is Darcy Daubaras, the Chief Financial Officer for HIVE. I'm joined on today's call by Frank Holmes, Interim Executive Chairman of HIVE. Before we begin, I'd like to remind you that during today's presentation, we will be making comments containing forward-looking information. I invite you to read our financial disclosure for some of the risks and uncertainties that may affect HIVE's performance in the future. And as such, actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult our most recent MD&A and filings on SEDAR. We will also be referencing non-IFRS measures. Reconciliations of these measures are included in our MD&A. Unless otherwise indicated, please note, all figures are US dollars. I'd like to now call -- turn the call over to Frank Holmes.

[Frank Edward Holmes, Interim Executive Chairman & Interim CEO]

Thank you. Darcy, and good morning, everyone. I want to thank all the shareholders who have been loyal through the -- what they call the crypto winter that basically bottomed in prices a year ago, approximately in February 14. It was a Valentine's gift from JPMorgan on February 14, 2019, when they rolled out the first U.S. bank-backed cryptocurrency to transform payment of business, and that seemed to be the big surge that we started seeing. And then comes out Libra. And we also then have a backlash against Libra from Facebook. But what's interesting is that the currencies rallied, but the enthusiasm for a lot of the stocks was really muted compared to the overall price change in the bottom. And that's a classic bottom. And I think what we've seen in the beginning of this year is a lot of selling pressure for HIVE last year took place until the end of December, and that seemed to abate. And then we start seeing now we're back to following, tracking the price of, particularly, Ethereum. So as Darcy commented that I am the interim CEO, and this saves the company a fair amount of cash and money because it comes basically being run by 3 people. And so it's very lean, and that's as important as that's how you survive through what's called a crypto winter. So let's talk about some of these highlights on Slide 4. I -- like during Q3, we generated $5 million income from digital mining of both Ethereum and Bitcoin. Gross mining margin was $3.8 million. However, as Darcy will discuss in more detail. Excluding certain items, underlying gross mining margin was approximately $1.1 million. As I've noted previously, our priority since we assumed management in the latter part of 2018 has been on strengthening our operational control and that real control took place when we started, we said an agreement signed in June of 2019. But what soon -- since then, we've done everything to strengthen our operational control for HIVE, including improving transparency, accountability and financial controls and improving our operational efficiency, including optimizing cost structures, to set the foundations for profitable growth. These efforts have begun to bear fruit. For the first 9 months of fiscal 2020, our gross mining margin was 26%, or 37% excluding upfront energy cost, compared to 24% in the same 9 months of 2018, with an increase by improvements to the mining profitability of our facility in Sweden due to our assumption of direct control of the relationships with the local energy suppliers and our move to a new service provider arrangement for our GPU mining facility in Sweden, which was completed in November; and our decision to prudently suspend Bitcoin mining in Q3 after a sharp increase in mining difficulty that resulted in our cloud mining operations becoming unprofitable. This appeared to be because of the S17s, the new ASIC chip, was being sold and being applied. And all of a sudden, we had it was called an increase in the difficulty of the cost of mining a Bitcoin. And so the S9s were not as profitable unless you had extremely cheap electricity. But what we want to go on with is talk about the post quarter, and we entered into hedging agreements. So I think this is important related to our electricity prices in Sweden for 2020. Combined with our service provider change in November, we anticipate a 40% reduction in our operating and maintenance costs in 2020 versus our -- under our previous service provider arrangement. We have much better control, setting up hedging and negotiating. And Darcy, our CFO; and Tobias, our -- Tobias Ebel, who's been a very loyal Director who's also a classic musician and tax lawyer, has been very helpful in the whole transition and managing everything for us in Sweden and all the relationships. And so that idea, that concept of being able to hedge your electrical cost is very, very vibrant in Sweden. And so we were able to take advantage when a warm -- what's called an unusual warm winter, the price of electricity fell to a couple of pennies, approximately. And so we started the process of putting up capital necessary to lock in that hedge. So we have more stability in our cost structure for the next year. We ended the quarter with a $6.2 million cash position and cryptocurrency inventory of $3.4 million, with working capital of approximately $11.8 million. Our strengthened balance sheet and greater cost certainty enables us to make appropriate investments to drive future growth. We continue to look at ways to optimize our other areas of operations, and we are assessing expansion opportunities and the best use of our capital going forward. Now I'd like to turn it over to Darcy for a deeper deep dive into the financial results.

[Darcy Daubaras, Chief Financial Officer]

Great. Thank you, Frank. As you can see on Slide 5, we generated income from digital currency mining in the third quarter of $5 million, with coin production of 23,000 Ethereum, 33,000 Ethereum Classic and 127 Bitcoin. This decrease was driven by our suspension, as Frank had mentioned, of Bitcoin mining in the third quarter as part of our focus on improving mining profitability. The significant increase in Bitcoin mining difficulty resulting in our mining operations, which operated on a fixed cost basis coming unprofitable. Turning to Slide 6. Gross mining margin during the third quarter of fiscal 2020 was $3.8 million or 77% of income. However, it was approximately $1.1 million excluding the reversal of the value-added tax provision originally recorded in the second quarter of fiscal 2020. As well as upfront energy costs paid during the quarter in Sweden, for which the company anticipates receiving energy rebates in the future. This compares to $2.2 million or a negative 27% in the same quarter of fiscal 2019 in the prior year. The increase in gross mining margin was driven by an improvement in profitability of our company's Ethereum mining operations in Sweden due to a change in its service provider relationship as partially offset by a reduction in Bitcoin mining profitability. I will highlight that gross mining margin. It is a non-IFRS figure, which is calculated as the value of coins received at the time of mining, less operating and maintenance costs. Flipping forward to Slide 7. Net income for the third quarter was $3.4 million. The year-over-year increase was driven primarily by the improvement in gross mining margin. An impairment charge taken in Q3 of fiscal 2019 and a decrease in depreciation expenses in fiscal 2020, stemming from impairments taken in the prior fiscal year. Turning to Slide 8. We increased our working capital during the quarter. Our cash position stood at $6.2 million at December 31, 2019, along with an additional $3.4 million in digital currencies and $7.9 million in accounts receivable and prepaid, which includes the energy tax rebates in Sweden that I previously noted. We maintained a strong net cash position and healthy working capital to fund our operations and growth. Turning to Slide 9. We outlined our current coin inventory, which we hold in so-called cold storage. During the quarter, our inventory decreased as we suspended mining of Bitcoin during the quarter. On Slide 10, we outlined the dollar value of our coin inventory at December 31, 2019, which has decreased this fiscal year partially due to the decline in Ethereum price from March 31 to December 31, 2019. I would like to now turn the call back over to Frank Holmes.

[Frank Edward Holmes, Interim Executive Chairman & Interim CEO]

Darcy, what's important in that visual you just showed is just the surge that has taken place since January 1, 2020, a leap year. And Ethereum, I think, closed roughly around $150 at year-end 2019, and is trading like $220 -- $226. So that idea that inventory of carrying that through is really -- we see a big appreciation coming this quarter. And I think that that's what I've noticed is an important part and I get contacts from investors. What is your -- that inventory? So thanks for highlighting that. What is the blockchain? I'd like to turn to Slide 11, as you can look into the current future conditions for blockchains acknowledging its impact on the cryptomining, especially with the increasing attention being paid to this year. The IDC defines blockchain that digital distributor ledger. As Fidelity notes, it's essential as a database that does not store information at a single computer server or physical location compared with traditional information databases. Instead, a blockchain is hosted by all computers across the network that store information. This allows for publicly available and readily viable information. I gave a speech. I spoke at Harvard earlier this year to an MBA class, and it was on this sort of concept. and I spoke to my fellow CP -- CEOs earlier in February also at Harvard. And what I thought was interesting was the concept is still very, very difficult for people. So you want to click visual, think of a safe. And a safe has usually 3 numbers. You have to twirl back and forth, and you can open up your safe and inside is the goodies. It can be a brick of gold, it could be documents, et cetera. And so what is important for people to realize is that this safe that, in the blockchain, it's 64 numbers and letters. So it's 64 digits. So it makes it very difficult to easily unlock unless you have high computational power to be able to lock it, unlock. And all the safes are for public to see, but the transaction that -- or what are the goodies inside of that safe, they're private. No one knows what's inside, who that transaction was between 2 people, but they know where the transaction took place in cyberspace. And all those safes are locked up one on top of the other. So that concept of being a bunch of safes, people have to come in and validate that there was nothing hurting their safe. It is protected, which -- who did what transaction within it. And then it goes along -- the sort of long chain that the public can see. And they can see if it went into the dark pools. They could see it was a bag -- a safe and immediately, with all the new security that's out therefore for KYC and AML software and correction software, you can quickly isolate that. Like software tries to isolate people that attack you with malware. I -- and so it's as important to see that visual. For me, it was everyone sort of then grasped the concept. And when it comes to Ethereum, what you put in it is basically agreements. You put in there, your will, your property title, you can have other information in that smart contract. But once again, everyone can see the safe, where it's been, but they can't see what's inside the safe. It's the easiest metaphor to grasp the concept for those that are trying to understand what HIVE's business is. And it's important for you is that we mine virgin coins. The other thing is when I was at Harvard and also recently at a crypto event in Switzerland. This is the most used visual and it's a Gartner cycle, and it talks about where HIVE takes place and being so exponential. And then they fall. And they call that fall can last a year, can last 10 years. For artificial intelligence, it was over a decade that it was a decade of a winter season that there's hardly any developments, the crash of 2000. Then the Googles came out, then came out other apps, et cetera, and the Internet flourished after the big hype of eyeballs and click-throughs. Then we had a real sound business. And it appears that's what's taken place with the blockchain, Bitcoin, whole phenomena of this exponential rise, this crash. And as it closed, slowly comes out of it, the digital landscape starts to change. And I think for investors, it's important to recognize that we're in a transition right now. And it's a very wonderful opportunity to take a look at what takes place when you compare to other breakthroughs in technology and the adoption of a new technology. And I think there's a great slide that was just given by Robert Friedland at the BMO Mining Conference, that's hard rock mining. And he showed that within a decade, there's a great photo of looking at 5th Avenue where there was only one car and everything was horse and buggies. And within a decade, there was all cars and there was only one horse and buggy. So these things take place, and then that was very tangible, but now it's a digital world, for investors to recognize, we are -- we've come out of this trough and the new players will evolve with it. So on Slide 13, as you can see, more institutes -- adoption is anticipated to result in more spending on blockchain. The IDC predicts like global spending on blockchain will grow at a 60% CAGR from $1.5 billion in 2018 to $15 billion in 2023. The banking industry is expected to be the largest adopter followed by certain manufacturing industries. And this whole idea that when I was talked about when I first got involved of looking trying to launch an ETF from this space and going to a -- the biggest conference in New York City and seeing the CEO of Fidelity speak about blockchain and crypto. And she had her own machine in the office, that was a big wake-up call. As a CFA, she never speaks at investment conferences, but she's speaking at -- here we are at the largest crypto conference speaking about their push forward because they see it as a very significant factor for the back office. So now I'd like to go on to the next slide. As you see on 14, it outlines a wide variety of uses for blockchain technology that companies are undertaking. A recent survey by Deloitte indicated that leading uses include data validation, data access and sharing, identity protection, payments and digital currency. These are driven by the inherent security and transparency of a distributed ledger technology. For example, 95% of survey respondents see smart contracts as an important blockchain capability, something Ethereum is known for. And that's why we've focused on Ethereum from the launch of HIVE and then gone back to it being so important for us in generating revenue and cash flow. The next slide, please. Ethereum can help enable blockchain adoptions. 45% of respondents to the Deloitte survey say their organization or project is focusing its activities on a public blockchain like Bitcoin and Ethereum, which as seen on Slide 15, satisfying the 5 properties required of a distributed ledger technology system. The blockchain eliminates the need for an independent third party to validate transactions as the blockchain is able to ensure transactions and information are correct. So what happens when you think of this in the cyber world? You have 10,000 nodes around the world that are validating the chain of all these safes, as I mentioned earlier, as a metaphor, where Ethereum even has more nodes around the world validating these transactions. So there's not one major place doing it like MasterCard or Visa, it's a distributed process. And next slide, please. So on Slide 16, we highlight that this is where HIVE comes into play. We are the record producers in DLT systems, also called miners, as we mine newly minted coins, such as Ethereum, also known as -- in our process of creating that first coin is called the genesis coin or the virgin coin. We serve an essential function in the protocol by securing the distributed network, consensus through proof of work. Public and enterprise blockchains are secured and maintained by miners, which are nodes of computers that validate and process the transactions of the blockchain. Validation and processing requires substantial computational power. And I think it's also really important for you to understand is that there's like 30,000 people employed around the world in this ecosystem of Ethereum that are -- and we just saw that part of consensus is merging with JPMorgan and putting their blockchain technology together. And they have one of the highest concentration of coders and scientists that were working on Ehtereum and uses of Ethereum. So I think that this thought process is so important to recognize, it will continue. And so when we look at -- coming back to this sort of these visuals for you, the miners update the blockchain by adding a transaction to the mutable blockchain. Miners are rewarded with newly minted cryptocurrency such as Ethereum for participating. And for those that are aware, that's how we get paid. When we go validate a transaction, we earn new Ethereum coins. And that's the -- the algorithm has been set. It's also for Bitcoin. It's set that way. And Bitcoin's going to go through what's called a having, where the reward is going to have in June of this year, late May. And that will be a big game-changer for the Bitcoin space. Slide #17, factors impacting HIVE's gross margin profitability. So HIVE's gross mining profitability is impacted in 3 ways: Our hash rate or mining capacity; and power consumption, which we aim to optimize, as I mentioned earlier; and market factors that we cannot control, such as the price of coins we mine and the network or hash rate or mining difficulty, and that means how many people are actually coming in to mine. The more people that want to come in and mine, they -- the less you get because it's basically a fixed number of coins every 14 minutes that you get an opportunity to go and compete and earn coins for. And so to recognize that there's less players, then we get a bigger market share. And that's what happened earlier this year that the coders in that ecosystem had basically made it difficult for ASIC chips to come in and mine Ethereum and it's predominantly GPU chips. And so immediately, the number of people mining Ethereum dropped off. And that really helped us in expansion in the number of coins we're competing for each 14 minutes. Slide #18. Since current management has assumed control in the latter part of the calendar year in 2018, which is really sort of the -- our year was 2019 fiscal year, and we are focused on improving our operational efficiency by entering into new service provider relationship to optimize our facilities on lowering our operating expenses through direct contracts with local energy suppliers, whereas Tobias has done a great job in facilitating for us. And we also want to thank Milan Hispanic, a block-based group, who's done a wonderful job in giving us the transparency and the information and so that we can make quick decisions, such as for a short period of time, we started mining more Ethereum Classic because the profit margins were 10% greater. And as soon as those margins went away, we went back to Ethereum. So we're much more fluid and we are able to go and optimize what coins are -- have the highest profit margin. And sometimes it can last months; other times, it can last weeks or days. And the ability to turn on a dime is much more easy for us to -- and for Balados and his group, to facilitate this. And also, [ Merin Baxa ] who's been with the company originally, and he's with the [ Biraja ] group out of Croatia. And he's doing a great job in helping us to get control of our costs to optimize our efficiencies. So it's been a great team effort. But we have not had control of the external mining market factors, and that's what's really important for everybody, just to recognize what do we control? And the price volatility is also important. And with this volatility, we are kind of a rider, bit just the regulatory and taxation when you go global is very complex and moving and changing by the quarter. So these are some of the other factors that we have to adapt to, just like we've got it up this past year when you've got -- you basically have a mark-to-market coming back in all your balance sheet and income statement, how they serve or bleed together. So that's what we want to make sure investors are aware of that we are doing everything with a lean machine to navigate many of these external forces. 21. So what you're seeing here is important is that the price rise in Ethereum has been correlated with HIVE's share price rise. And you can really see this with the 50-day moving average. It's not here, but the 50-day basically broke out in mid-January. That is Ethereum went above the 50-day. Sorry, there, in 21. It went above the 50-day and our volumes start to explode. And the same thing with sort of the interest in HIVE as your theory went up. And what's interesting is that our cost structure, where it was, all of a sudden, anything above $165 really had a big kick to our profit expansion. And with Ethereum running up to $280, I think that this is one reason why the selling pressure had basically gone away. As people are tax loss selling at year-end of last year. And Ethereum now breaks out and our profit margins start to expand. The adoption and the following that the following we have, the global following of HIVE, showed up in almost an exponential increase in daily trading volume. And so we will move, and we're moving, I think, we believe at 82% correlation with the Ethereum prices today. On Slide #22, it illustrates the increase in HIVE's share price has been mirrored through a surge in trading volumes. And we see this, not only just in Canada, when you look at the U.S., when you look at Germany, when you start putting them all together, we had some days. I think, Darcy, was it 30 million-share days?

[Darcy Daubaras, Chief Financial Officer]

Yes. No, they were very -- it was around 30 million across all of the exchanges in Canada.

[Frank Edward Holmes, Interim Executive Chairman & Interim CEO]

And so when you start adding that, we are the, I believe, the go-to fluid name. So that's where we want to thank all those shareholders who stuck with us throughout the whole decline and believed in our vision and had faith that we would be able to come back, and that's what we're doing today. Slide #23. So HIVE outperformed the coins in competition. And I think the other part was that during the bear market, we continue to do presentations to our shareholders and conferences explaining, especially, it was in the U.S. and in Europe, meeting with institutions, meeting with what we call registered investment advisors, explaining to what was taking place, how we were weathering this storm. And as Ethereums come back, so have these investors. So I think that's been really shown that the people having faith in the company as HIVE has outperformed the coins and the competition. And it reminds me of what they called [ in-barging ] a gold mine company. That as the price of gold cost higher, all of a sudden, there's explosive moves in gold stocks. And these used to always be South Africans because they were the high-cost marginal producer. They had massive gold production, but they had a higher cost structure. And once gold went through that magic number, they went up exponential relative to the Barricks and the Newmonts. And you can see, as I said earlier, that when Ethereum broke above this 50-day moving average, it's showed up in [indiscernible] HIVE.Next slide, please. So this is important as I -- before I turn it over to Q&A and to Darcy. Crypto assets remain very, very volatile. And this is a 10-day standard deviation known as 1 sigma looking over last year. It's a nonevent for the S&P over a rolling 10-day period, that's a 2-week period, to go plus or minus 2%. Gold is basically the same as the S&P 500, plus or minus 2%. But Bitcoin is 14%, 7x greater volatility; and Ethereum is 6x greater volatility. And not only as do you have the price volatility we have to try to manage, we have to manage with all these global taxation and regulatory pronouncements. Wherever you go through Europe, each country has a different -- it appears like a different definition of what a Bitcoin is or what Ethereum is. And so we're trying to navigate through those waters. And we've employed a lot of top tax lawyers, the largest law firms in the world. We have major audit firms, just trying to make sure that we're always keeping up to speed with changes in regulations. Now I'd like to turn it over to Darcy.

[Darcy Daubaras, Chief Financial Officer]

Yes. I was just -- to follow-up with Frank in terms of just the advantages and just the growth that we've had since we've come on in 2018 has just been incredible. It's a very volatile market that we deal with it, but we're doing the right things by hiring these international tax and accounting firms to assist us with our global reach that we've got in the countries that we operate in. So with that -- sorry, go ahead.

[Frank Edward Holmes, Interim Executive Chairman & Interim CEO]

I just like to add, Darcy. We're the first really to take the more conservative role in taking charges on the depreciation. So for investors, the -- there's like a straight-line depreciation for this -- these equipment that you buy. You buy ASIC chips or you buy GPU chips. And it seems that the Chinese -- or their ASIC chips cannibalize themselves much faster than the normal decline you're allowed to and depreciation. And so with the crypto winter, the prices fell and so did the chips, and the chips fell like 90%. And so we thought it was just best because of the new chips that are coming out, the S-17, that we took, last year, a much more conservative stance and took write-downs against the value of those chips and those investments we made. And I think that, that's what we're trying to do because these factors outside of us are volatile and we're trying to adapt and adjust to them.

[Darcy Daubaras, Chief Financial Officer]

That's great, Frank. So I think with that, and with the markets starting to open, I think we'd like to thank our investors, as Frank had mentioned at the beginning, for your ongoing support. We can't do it without you. We feel that we're doing the right thing, reducing costs, controlling those things that we can control, and we're going to continue to do that and make it through this time of the industry trying to come together and get some standards and just try to become that lowest-cost, best company out there for investors to use as a proxy for Bitcoin and Ethereum Perfect.

[Frank Edward Holmes, Interim Executive Chairman & Interim CEO]

Thank you.

[Darcy Daubaras, Chief Financial Officer]

So with that, I think, unless there's something that's popped up, we'd probably like to end the call.

[Frank Edward Holmes, Interim Executive Chairman & Interim CEO]

Thank you.

[Darcy Daubaras, Chief Financial Officer]

Thank you very much, everybody. Have a great day.